This article was reviewed by Jay Brecknell, CFP®.
Planning for retirement can be—and we argue it should be—exciting. It’s a time to dream about what you want to do and put a plan in place so that you can actually do it.
But there’s a lot of information to sift through and this exciting period can quickly get overwhelming.
The thing is, by learning about the tools at your disposal, you’re able to make more informed decisions and enjoy those golden years you’ve worked so hard towards. We continuously see this with our clients.
One of those tools is your RRSP. Most people have heard of RRSPs and have a basic understanding of them.
But what exactly are they? How do they work? Where do they fit in your retirement plan, and how do you make the most of them?
Those are different questions altogether. In this article, we’re going to take a deep dive into RRSPs, so you can emerge feeling a little bit less intimidated and a whole lot more empowered.
What is an RRSP?
A Registered Retirement Savings Plan (RRSP) is a type of savings account that’s registered with the federal government that was introduced in 1957 to encourage Canadians to save for retirement. If you’re familiar with the US system, RRSPs are the Canadian equivalent of the 401k.
RRSPs are an investment vehicle where pre-taxed money is placed to grow tax-free until withdrawal, at which point it is taxed as income. You can hold a variety of investments in your RRSPs, including
- Stocks
- Bonds
- GICs
- Mutual funds
- ETFs
- Index funds
- Cash
There are three main benefits when it comes to making RRSP contributions:
- They are tax-deductible so they can be used to offset your income in higher earning years
- They grow tax free while they’re sheltered in an RRSP account
- They are tax-deferred savings, meaning you don’t pay taxes until you need to withdraw from your account for income once you’re in lower earning years
There are two other types of RRSP accounts you’ll often encounter and these are:
- Group RRSPs
- Spousal RRSPs
Let’s take a quick look at both of these.
Group RRSP
A group RRSP is a savings plan that’s offered through an employer. It works like an individual RRSP, with the added benefit of giving you the option to have your retirement savings deducted straight from your paycheques and potentially be matched by your employer.
Spousal RRSP
A spousal RRSP is an account where you can contribute money to your spouse’s (or common law partner’s) retirement plan, allowing you to spread out the tax benefits upon withdrawal.
This is a great way to split income for retirement when you have one spouse who earns significantly more than the other.
How do RRSPs work?
So now that we’ve got an idea of what RRSPs are, let’s take a look at how they work.
You make contributions to your RRSP account (or your spouse’s); then you report those contributions to CRA when you’re filing your taxes to receive a tax deduction and—if you’re lucky (or have a good financial planner)—a tax refund. Your contributions grow and compound tax-free.
If you want to know approximately how much of a refund you’ll get from your contributions, you can use an RRSP calculator, like this one by TurboTax.
If you withdraw money from your RRSPs, that withdrawal is subject to a withholding tax from the financial institution where you’re holding your RRSP and, unlike with a TFSA, it counts as income. You also lose that contribution room (we’ll talk about contribution room in a second).
After December 31 of the year you turn 71, your RRSP matures: you can’t make any more contributions and have to do something with the funds. You can either cash them out, buy an annuity or—the most recommended option—convert them to a Registered Retirement Income Fund (RRIF).
You can convert your RRSP into a RRIF to start drawing an income, at any age. If you do, you need to start drawing the minimum required amount every year, which will be taxed at the marginal rate.
Upon death, RRSPs can be transferred to a surviving spouse tax-free, and when they die, the entire RRSP gets taxed as income on the final estate.
How to use RRSPs
The whole premise behind making RRSPs work is twofold: one is to put money into your RRSP while you are in a higher income tax bracket. The second is to use your refund wisely. We recommend using it to make additional contributions to your RRSP or your TFSA or to pay down outstanding debts like your mortgage.
Check out a few more strategies we have for making the most of your RRSPs.
RRSP contributions
Who can contribute to an RRSP?
Anyone who has earned an income, has a social insurance number and has filed a tax return can contribute to an RRSP until December 31 of the year they turn 71 (you can contribute to your partner’s spousal RRSP until the year they turn 71).
When is the RRSP contribution deadline?
By the time you’re nearing retirement (or already in retirement), you probably know that the RRSP contribution deadline is not the end of the calendar year.
It is delayed to give tax payers the opportunity to identify how much income they’ve earned in the tax year, so they can make contributions to offset that income as much as possible in order to reach their financial goals.
RRSP deadline 2022
The annual deadline for contributing to your RRSP is 60 days after the last day of the calendar year. For the 2021 tax year, your RRSP contribution deadline is March 1, 2022. That means you can make RRSP contributions all the way up until March 1.
Contribution room, contribution limit, deduction limit
We’ve been throwing a lot of these terms around, so before we move on, let’s take some time to properly define them.
RRSP contribution
This is how much money you’ve contributed to your RRSP in a calendar year.
RRSP contribution limit
You can only contribute a certain amount to your RRSP every year. This is known as your contribution limit and it is set by the CRA. Your contribution limit is the lower of:
- 18% of your earned income from the previous year
- The maximum annual contribution limit for the current tax year ($29,210 for 2022)
- The remaining limit you might have after any company-sponsored pension plan contributions
RRSP contribution room
Every year that you earn income, you earn RRSP contribution room. If you have unused contribution room (i.e. you haven’t contributed the maximum amount available to you in that year), that contribution room carries over until you can no longer contribute to your RRSP (December 31 of the year you turn 71). Unlike with a TFSA, if you make a withdrawal from your RRSP, you don’t free up that contribution room, but lose it forever.
RRSP over contribution
What happens when you go over your RRSP contribution limit?
If you don’t have any available contribution room, then you’ll have to pay a penalty of 1% per month on excess contributions that exceed your limit by more than $2,000. To avoid that penalty, you’ll need to either withdraw excess amounts or contribute to a qualifying group plan.
You can see how much contribution room you have on your Notice of Assessment.
RRSP withdrawals
Generally speaking, it’s never a good idea to withdraw money from your RRSP before you retire. Not only do you lose your contribution room and your withdrawals get taxed as income (which usually leads to a hefty tax bill), but you’ll also be subjected to an RRSP withholding tax from the financial institution where you’re holding your RRSP.
RRSP withholding tax
- 10% (5% in Quebec) on amounts up from $0 to $5,000
- 20% (10% in Quebec) on amounts from $5,001 to $15,000
- 30% (15% in Quebec) on amounts over $15,000
Source: Canada Revenue Agency
However, there are two exceptions when you can take money out of your RRSP without incurring a tax penalty, thanks to programs the federal government has put in place: for the purchase of a home and for going back to school.
Home Buying Plan
The Home Buying Plan is a program that allows first-time homebuyers to withdraw up to $35,000 from their RRSP tax-free ($70,000 for a couple) to buy or build a home.
It works like a loan that you make to yourself: you withdraw funds from your RRSP free of interest. Your withdrawals don’t count as income but you you have to pay back 1/15 of the amount you’ve taken every year and have the full amount repaid within 15 years.
You can make additional contributions to pay it back faster but any contribution made to pay back the HBP won’t receive a deduction. Additionally, if you miss a repayment in one year, that amount gets taxed as income.
Eligibility requirements for the Home Buying Plan
- You have to be a first-time home buyer (for the purposes of the program, you’re considered a first-time home buyer if in the four years before your purchase, you didn’t live in a home that you or your spouse or partner owned)
- You have to be a resident of Canada when you withdraw funds from your RRSP and up to the time your home is bought or built
- You have to intend to live in the home as your primary residence within one year of buying or building it
- If you’ve previously participated in the HBP, you can participate again if you’ve completely repaid your HBP balance and if you still meet the other eligibility requirements
There are also additional accommodations if you’re helping somebody with a disability buy a home.
Overall, this is a great program to help people get an interest-free down payment to buy their first home.
Lifelong Learning Plan
The Lifelong Learning Plan is similar to the Home Buying Plan and allows you to withdraw up to $10,000 from your RRSP in a calendar year for a total of up to $20,000, for the purposes of going back to school full time.
Like the HBP, you withdraw funds from your RRSP interest-free. Your withdrawals, again, don’t count as income and you have to pay back 1/10 of the amount you’ve taken out and have repaid the full amount within 10 years.
Eligibility requirements for the Lifelong Learning Plan
- You have to be enrolled or have received an offer to enrol as a full-time student in a qualifying educational program at a designated institution
- You must be a resident of Canada when you make your withdrawals
- There are no limits to the number of times you can use the LLP. Once you pay back what you owe and meet the eligibility requirements, you can do it all over again.
When should you convert your RRSP
Your RRSP is a vehicle for saving for retirement. When it comes time to start drawing an income from your savings, you need a different kind of account. The most common kind is the RRIF.
We’ll look a little more in-depth at how a RRIF works in a future article.
Converting an RRSP into a RRIF is often made out to be a big event, but in our world it’s quite simple. We just open a new RRIF account and transfer the assets from the RRSP. Easy!
A lot of people convert their RRSP to a RRIF when they retire—or shortly after—when they need to use them to draw an income.
Others may have various income sources that make more sense for them to draw from when they retire: maybe they are still working or they’re receiving a corporate buyout. In those cases, it often makes sense to wait until the last possible moment to convert.
How much should you take out?
We like to think of income sources as water faucets: some you can turn on but then cannot turn off (government and private pensions). Some you can turn on but then can only turn down, not off (RRIFs). Then there are the ones you can turn on and off (TFSA and non-registered accounts).
We always start by looking at the best combination for our clients based on taxation. Then we typically use the ones that can’t be shut off and build from there.
So when you’re looking at when you should convert your RRSP into a RRIF and how much you should take out, the answer is always: it depends. It depends on the other income sources you have at your disposal and how much you have available to you in those sources.
Take the stress out of retirement planning
That’s it! You now have a good idea of what an RRSP is. You also have a better understanding of some of the ways you can leverage its benefits to help you save for your retirement.
Some people think that RRSPs are becoming an antiquated tool. Don’t listen to them. These are robust savings vehicles with terrific benefits, especially when you’re in your higher earning years. However, that doesn’t mean there aren’t other accounts worth saving in.
Learning about how RRSPs work is just the first step, though. We’ve put together a free retirement planning worksheet to help you work through the steps you need to take to prepare for that incredible journey.